Italian borrowing costs fall on reports of a lower deficit in the coming years

  • The market reaction followed reports by the Italian newspaper Corriere della Sera that the government is planning to lower public deficit from 2.2 percent in 2020, to 2 percent in 2021, from an expected 2.4 percent next year.
  • Renewed fears that the Italian government could consider an exit from the euro zone pushed borrowing costs up on Tuesday.
ROME, ITALY - JULY 24: Prime Minister Giuseppe Conte and the Minister of Economy Giovanni Tria attend a press conference in Palazzo Chigi.
Simona Granati | Corbis News | Getty Images
ROME, ITALY - JULY 24: Prime Minister Giuseppe Conte and the Minister of Economy Giovanni Tria attend a press conference in Palazzo Chigi.

Italian borrowing costs have fallen early on Wednesday morning as investors digested news that Rome could lower its public spending in the coming years.

The yield on the 10-year Italian bond fell 3.31 percent at about 7.40 a.m. London time.

The market reaction followed reports by the Italian newspaper Corriere della Sera that the government is planning to lower public deficit from 2.2 percent in 2020, to 2 percent in 2021, from an expected 2.4 percent next year.

This was seen as a relief for bond markets, especially since the bond market has been on a roller-coaster ride in the last few weeks.

Investors have been on the edge regarding extra spending in Italy since the appointment of a populist coalition government, last Spring. The cabinet has promised a number of populist measures that risk the stability of Italy's finances.

As a result, Italy announced last week that the deficit for 2019 would be 2.4 percent of GDP, to incorporate the different populist measures. Markets were not pleased with the number, given that it was three times higher than what the previous cabinet had planned.

Fears over Italian exit

More recently, renewed fears that the Italian government could consider an exit from the euro zone pushed borrowing costs up. Claudio Borghi, who leads the economic policy of the ruling Lega party, cast doubt over Italy's membership of the single currency on national radio Tuesday. His comments prompted the yield on the 10-year Italian bond to rise to 3.40 percent — its highest level since March 2014. This was not the first time that members of the right-wing Lega party made similar remarks.

Valentin Marinov, head of G10 forex strategy at Credit Agricole, told CNBC Wednesday that the 3.4 percent level was worrisome.

"Things to worry about is the fact that BTP yields have gotten very close to the 3.5/ 4 percent, which accordingly to our own colleagues on the rate side could push us in a snowball territory whereby the debt could start growing so rapidly," Marinov told CNBC's "Squawk Box Europe" on Wednesday morning.

He added that "what we are dealing with is a relatively big economy, with a lot of debt, aging population and not very decent growth prospects."

Italy holds 2.3 trillion euros ($ 2.67 trillion) worth of debt, which represents about 130 percent of its total growth.

The populist government in Italy is hoping to curb the debt pile with a solid growth rate. The finance ministry is forecasting a 1.6 percent GDP rate in 2019 and 1.7 percent in 2020. Some analysts believe that these figures are very optimistic.

The Italian government is still working on the final details of its 2019 budget. But the final document is due to be ready by the 15th of October.

A downgrade?

Some analysts expect Italy will have its credit ratings downgraded on the back of the extra spending.

"New spending on growth-enhancing investment might be forgiven but, even then, Italy is still likely to suffer at least one single-notch downgrade on October 26th," analysts at Macquarie group said in a note on Tuesday.

Though the final details on next year's budget are still being prepared, the Italian government has said that it will put money aside for investments.

"We believe the recent sell-off presents investors with an attractive opportunity to buy Italian two-year bonds. We caution, however, against holding long-dated Italian bonds and advise against any concentrated exposure to them.," Mark Haefele, chief investment officer at UBS Global Wealth Management said in a research note Wednesday.

UBS Global Wealth Management has opened a position in two-year Italian government bonds.